Modeling and forecasting outliers and level shifts in absolute returns

Philip Hans Franses, Marco van der Leij and Richard Paap

No EI 2001-34, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: Due to high and low volatility periods, time series of absolute returns experience temporary level shifts (that is, periods with outliers) which differ in length and size. In this paper we put forward a new model which can describe and forecast the location and size of such level shifts. Our so called Switching Regime Censored Latent Effects Autoregression [SR-CLEAR] assumes that technical trading rules may have explanatory value for future volatility. It is assumed that these rules have a time-varying effect on absolute returns, and that this effect appears as an outlier or a level shift. We apply the SR-CLEAR model to nine stock markets and we document its excellent fit and competitive forecasting ability.

Keywords: absolute returns; censored latent effects; outliers; temporary level shifts (search for similar items in EconPapers)
Date: 2001-11-13
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